1. Field of the Invention PA1 Ownership. As it is currently conceived, ownership is forever. There is no limit under the current business system to how long an owner can reap returns from an investment. But this need not be so. PA1 Taxation. Companies do not pay federal taxes on account of growth in value, until a taxable event occurs. The death of a corporation through liquidation can be a taxable event. Companies would rather live an unhealthy life than die and pay taxes. PA1 Bureaucracy's `Law`. It is in the nature of bureaucracies to get bigger. A bureaucracy (or a bureaucratic company) cannot get bigger if it dies. So it continues living at all costs. PA1 Pay. Executive pay is based on sales and profits, and no incumbent wants to take a hit. Managers would rather save the bad news for the next guy or gal. Lucky for them, many significant costs-for example, the cost of decommissioning a nuclear power plant-can be deferred indefinitely. By not reporting these future costs, and by externalizing other costs, the corporation can live forever, and always put off into the sunset the payment of expenses.
The present invention generally relates to a computer assisted and/or implemented process and architecture for simulating, determining and/or ranking and/or indexing effective corporate governance, and more particularly, to a computer assisted and/or implemented process and architecture for simulating, determining and/or ranking and/or indexing effective corporate governance using complexity theory and agency-based modeling.
2. Background of the Related Art
In the earliest days of free enterprise there was little distinction to be drawn between ownership and management of business entities. In most cases these roles were played by the same individuals, who brought to the economic system their own personal goals and aspirations and, in turn, their own sense of accountability. For better or worse, this direct personal involvement provided the essential driving force of our economic growth and development.
As these private enterprises grew and evolved, however, new forms of ownership emerged, beginning with the various forms of partnership and proceeding to the development of the modern corporation. In this form an immediate gap appeared, and then widened, between the functions of ownership and management. As a result, the direct human involvement of individual owners grew increasingly removed from management.
The need to bridge this gap has in turn provided the foundation for much of our contemporary system of contract law and our standards of accounting practice, all formal mechanisms devised to codify and monitor the various relationships between and within business entities.
The development of the modern publicly held corporation accelerated this process tremendously, as represented by the rise major US federal regulatory organizations ranging from the Securities and Exchange Commission (SEC) to the recently created Independent Standards Board, both powerful sources of standards for corporate life.
The key advantages of the corporate form-limited liability and a vastly expanded capacity for raising capital-have led in turn to the development of a corporate culture far removed from the greater concerns of individual owners, with a resultant focus on near-term growth and profitability. This tendency of large corporations to organize themselves around short-term interests is increasingly a matter of public concern. Despite the continued existence of other business forms, large publicly held corporations dominate the developed world's economic landscape.
The problem of `short-termism` is far more pervasive than critics have acknowledged to date. In the usual commercial parlance this is a term managers and others use to blame shareholders for their preoccupation with quarterly-even daily-results. This preoccupation, critics say has generated a culture antithetical to good management. The implication here is that if only shareholders would let managers manage, decisions would be made for the `long term`. Management and directors are likely to be limited to their own tenure, which is very rarely longer than 10 years. We will need a longer-term perspective, and we are more likely to find it in long-term owners.
In the absence of clear owner-driven values, the managers of many publicly held corporations have become increasingly powerful, filling boards to suit their own agendas and commanding enormous personal compensation and severance packages. These boards and managers hire corporate counsel on the basis of their ability to externalize accountability, ethically as well as economically. All too often, corporations use their powers of self-transformation to play a shell game. Instead of transforming themselves to enhance long-term value, many corporations use acquisitions, divestitures, and restructurings for lesser purposes-to control disbursement of profits to shareholders, to manipulate competition in the marketplace, or to avoid the payment of public taxes.
With their tremendous power to influence public policy and the public economy, these boards and managers have become increasingly accountable only to themselves. Instead of embracing the challenges of adaptation to and effective engagement in a dynamic, living economy, these short-term driven companies seek to bend the rest of the economic system to their own needs.
Historians may well look back on the 1990s as a time when corporations trampled the public interest in the pursuit of their own ends. Few in our time would share that view.
This brief history of the corporate form represents our best attempt to explain in plain English what can happen when ownership and management separate. In facing this problem, we have to stop looking for a familiar answer based on human experience.
Corporations are neither people with hearts nor machines with perfect logic, but rather systems with their own dynamics, driven entities that seek unlimited life, size, power, and license, eventually to the point of threatening the entire economic system with the loss of credibility-and, perhaps existence.
CORPORATE DANGER #1: THE QUEST FOR UNLIMITED LIFE
Corporations collectively may have perpetual life as a species as long as they remain harmonious with the principles of nature. Individually, however, corporations should risk mortality. Yet they avoid this risk, impelled by the fundamental law of bureaucracy, and helped by current systems for ownership, taxation, and pay.
This last point is worthy of special attention, because it has caused a change in the theory of executive pay. Once upon a time, only owners reaped huge rewards from the growth of a company. Now it is any current manager!
CORPORATE DANGER #2: THE QUEST FOR UNLIMITED SIZE
Growth is not always pretty. It can come from positive feedback--a kind of geometric pattern that can `lock in` inferior technologies. The result is growth of a product (and its makers) that comes not from merit but from a chain reaction. A common example of lock-in is VHS versus Beta for videos. The latter was better but came too late to succeed.
Just as organisms within a lineage tend to increase in size so corporations tend to increase in size. Like long corporate life, big corporate size can evolve irrespective of merit. As a corporation increases in size, it also increases in complexity. To increase in size requires funding, which comes from profits. How does a corporation's quest for profits affect its behavior?
The corporation's search for profits is `relentless`. A company is held to account in the marketplace. One of the principal elements of a company's marketplace appraisal is its performance as recorded by certified public accountants. Bolstered by the professional education and prestige of accountants, the efforts of the SEC and of self-regulatory standard-setting organizations such as the Financial Accounting Standards Board and the New York Stock Exchange, `the numbers`-constrained by generally accepted accounting principles (GAAP)-provide a preponderantly honest and consistent picture which is susceptible of sophisticated interpretation.
But no one should be under any illusions that GAAP numbers provide a reliable basis for determining the value of a company. They are what they say they are-no more, no less-a statement of financial condition based on principles consistently applied. This is the essence of the corporation's mechanistic nature: something we must live with but something that we cannot assume has human interests at heart.
For example, in recent years, the integrity of GAAP numbers has squarely been strained by the continuing proliferation of `restructuring` charges. The pattern of taking a special charge to account for unusual and nonrecurring circumstances is doubtless a useful convention. The pattern of taking charges every year in amounts that often dwarf the reported `earnings` is to make a mockery of the whole process.
With the dramatic changes in corporate condition reflected by massive charge-offs, anomalies emerge that illumine the limitations of the process. For example, Westinghouse, one of the Dow Jones 30 companies in America with a seemingly sustainable capacity to generate a billion dollars a year of cash flow, has only a nominal net worth according to GAAP. `From 1991 to 1995, 26 of the companies that constitute the Dow Jones Industrials took 69 restructuring actions, including asset write-downs. In the process, they charged away more than $49 billion of stockholders' equity.`
A further problem with GAAP is that it places emphasis on traditional assets that have increasingly little to do with the generation of income in a world dominated by new invention and informed by the communications revolution.
An important corollary to the corporation's search for unlimited size is the aforementioned notion of externalities. In using the term `externalizing` here, we were referring to the externalization of costs-making others (taxpayers, customers, and so forth) pay for costs that should rightly be assumed by the corporation. The notion of externalities has received renewed attention.
Corporations are driven by the imperative of short-term value maximization. They want to have an immediate profit, and they do not care (remember, they are not human) if this profit is achieved at the expense of others, including future generations.
Corporations have wide and long-term social impact that extends well beyond those items that are generally included within GAAP. These externalities range from the costs of training, medical and disability expenses arising from work, unemployment, and impact on the environment.
CORPORATE DANGER #3: THE QUEST FOR UNLIMITED POWER
The rules under which corporations are chartered are created by the political government of their domicile. The `externalizing machine` inevitably inclines to attempt to dominate the sovereign. The most dramatic example of attempted dominion is the ability of the corporate community over the decades to dominate the quality of the legal professions and, thus, over time the interpretation of the law.
The extent of corporate involvement in elections has increased dramatically. One new pattern has evolved. To the consternation of Republicans, big business his persisted in contributing substantial amounts to both political parties. Republican congressional leaders threaten reprisals on those who support the enemy. A stronger imperative is involved for business. The political parties are, in effect, subsidiaries of big business. What is important is that the whole process become dependent on business' financial support. This, rather than the success of either political party, is the essence of corporate strategy.
The nature of political fund raising has changed the face of federal elections. We have been accustomed for a century or more to the spectacle of one special interest group or another `buying` access and influence. But that strategy now seems too modest. The Business Round table provides a new level of sophistication in political power and communication that business lacked in past times. It hedges its bets! Now large corporations give money to both political parties. What is at stake is not partisan favor, but domination of the entire political process by the business sector. Business money has become virtually intrinsic to the political process.
From power over elections flows power over lawmaking, another key threat within the danger of corporate power-seeking. Perhaps nowhere does the raw power of corporate energy reveal itself more obviously than in this infamous industry-ongoing in every capital city in every major country in the world, bar none. In Washington, D.C., the lobbying economy exceeds the government itself, and is growing geometrically. In the first half of 1996 alone, lobbyists spent $400 million to influence government.
The very existence of a huge lobbying industry in a free market economy bears testimony of its effectiveness: given such a huge investment in manpower, there must be some return from it. Those who seek such proof need go no further than corporate welfare.
Another mode of power sought by corporations is power over government resources--a form of entitlement otherwise known as corporate welfare. Wealth redistribution by government is increasingly important in contemporary society. It takes many forms: government franchises, contracts, subsidies, and the use of public resources. Corporations have effectively organized themselves to share in the `government created` wealth.
In summary, more PACs means more lobbyists means more corporate welfare and further skewing away from the public interest in the allocation of public resources. This vicious circle is self-reinforcing. Because representatives in the United States and other countries receive funds from industries represented by the lobbyists, there is virtually no political libido for taking on corporate welfare, notwithstanding that it has been identified and publicized by all shades of political sentiment.
Corporations also include power over `independent` agencies and professions. Corporations are able to pay the highest prices for goods and services. The most prestigious professions depend on securing their share of corporate business in order to prosper. This leverage has been compounded in recent times by increasing percentages of the `best talent` entering business related professions.
The movement away from the professions and toward businesses is driven in part by the simple fact that businesses yield more power than the professions. Proof of this fact can be seen in the stunning defeat of a sensible proposal for stock option accounting in the United States.
There has been great concern lately over the extraordinary increase in the level of compensation for the top executives of US corporations. The current levels of pay would have been unimaginable in earlier times in the United States-and they are utterly out of sync with the pay levels abroad today. Management pays itself without effective overview by anyone. In recent times, management has even managed to dominate the national accounting system with respect to a key aspect of its compensation: stock options.
Corporations also possess power over the judicial process. The sheer talent available to business has had vast impact in its relationship with government. Consider those situations where the stakes are high enough to warrant litigation. The antitrust suit that the United States government began in the waning minutes of the Johnson Administration and waged against International Business Machine Company for almost 20 years until the presidency of Ronald Reagan demonstrated the capacity of a private company with unlimited resources to create a legal competency that ultimately triumphed over the government.
CORPORATE DANGER #4: THE QUEST FOR UNLIMITED LICENSE
Just as the corporation externalizes costs in its quest for unlimited power, so it externalizes accountability in its quest for unlimited license. We take comfort in the existence of corporate criminal laws, but this very term is a misnomer. If a corporation commits a crime, how can it be punished beyond the payment of a fee?
Instead, corporations have treasuries to be fined. Thus from the perspective of the corporation, the decision whether to obey the law is one of many that involve a cost/benefit calculation. Will the costs of disobedience discounted by the probability of being discovered, prosecuted, and fined equal the costs of compliance?
Because we see corporations as people or machines, and not for what they are, we tend to minimize the effects of corporate crime. If we think of corporations as people, we might think they will somehow feel guilty. And if we think of them as machines, we might think they will break down, as crime does not pay. We fall to recognize that corporations do not respond to incentives and penalties applicable to human beings.
One of the competitive attractions of conducting business through corporate form is that liability for the venture's costs is limited to the amount of the investment. This `limited liability` notion appears to excuse shareholders from further responsibility respecting corporate property.
Plainly, corporations must exist in a civil society where the rules are made by governments. A decent relationship with government is essential for the operation of business. The corporation itself will need to exercise restraint in this regard, refraining from undue interference in lawmaking. Such restraint can help restore accountability to the corporation.